Financing of Projects

8/2/2019 Financing of Projects

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Presented by

Parikshit SahaPankaj LokeshRandeep GargSahil AggarwalNishant Adlakha


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Capital Structure Menu of Financing

Debentures Methods of Offering Term Loans Miscellaneous Sources Raising Venture Capital Raising Capital in International market


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DEBT EQUITY

Must be repaid or refinanced Can usually be kept permanently.

Requires regular interest payments.Company must generate cash flow to pay.

No payment requirements. May receivedividends, but only out of retainedearnings.

Debt providers are conservative. Theycannot share any upside or profits.Therefore, they want to eliminate allpossible loss or downside risks

Equity providers are aggressive. They canaccept downside risks because they fullyshare the upside as well

Interest payments are tax deductible. Dividend payments are not tax deductible

Debt has little or no impact on control ofthe company

Equity requires shared control of thecompany and may impose restrictions.


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Cost Nature of Assets

Business risk Norms of lenders Control considerations Market conditions


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InternalAccruals

Securities

WorkingCapital

Advances

TermLoans

MiscellaneousSources

Sources of Finance

Sources of Finance

Equity Debt

EquityPreferenceInternal Accruals

BondsTerm Loans Working Capital Advances

Miscellaneous Sources


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Internal accruals of a firm consist of depreciation charges andretained earnings. Depreciation represents the allocation ofcapital expenditure to various periods over which the capitalexpenditure is expected to benefit the firm.

Advantages:1. Internal accruals are readily available.2. It eliminates issue costs and losses on account of

underpricing.

Disadvantages:1. The amount that may be available by way of internal accrualsmay be limited.

2. The opportunity cost of depreciation-generated funds is equalto the weighted average cost of capital of the firm.


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Equity capital represents ownership capital as equity

shareholders collectively own the company. They enjoy the

rewards and bear the risks of ownership. However , their

liability, unlike the liability of the owner in a proprietary firm

and the partners in a partnership concern, is limited to theircapital contributions.

The book value of an equity share is equal to:

Paid-up equity capital + Reserves and surplus

Number of outstanding equity shares

The book value of an equity share tends to increase as the ratio

of reserves and surplus to paidup equity capital increases.


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Advantages:1. There is no compulsion to pay dividends.2. Equity capital has no maturity date and hence the firm has no

obligation to redeem.3. Equity capital provides cushion to lenders, it enhances the credit

worthiness of the company.4. Presently, equity dividends are tax-exempt in the hands of

investors.

Disadvantages:1. Sale of equity shares to outsiders dilutes the control of existing

owners.2. Cost is very high, usually the highest.3. Equity dividends are paid out of profit after tax, whereas interest

payments are tax-deductible expenses.4. Cost of issuing equity shares is generally higher than the cost of

issuing other types of securities.


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1. Right to income: The equity investors have a residual claimto the income of the firm.

2. Right to control: Equity shareholders elect the board ofdirectors and have the right to vote on every resolution placed

before the company. The board of directors, in turn, selects themanagement which controls the operations of the firm. Henceequity shareholders exercise an indirect control over the operationsof the firm.

3. Pre-emptive right: This right enables existing equityshareholders to maintain their proportional ownership bypurchasing the additional equity shares issued by the firm.

4. Right in Liquidation: Equity shareholders have a residualclaim over the assets of the firm in the event of liquidation. Claimsof all others-debenture holders, secured lenders, unsecured lenders,other creditors are settled prior to the claim of equity shareholders.


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Preference capital represents a hybrid form of financing- it

partakes some characteristics of equity and some attributes of

debentures. It resembles equity in the following ways

i. Preference dividend is payable only out of distributable

profits

ii. Preference dividend is not an obligatory payment

iii. Preference dividend is not a tax-deductible payment.


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Cumulative and Non-cumulative shares: Cumulativepreference shares entitle the shareholders to receive dividends for theprevious years in which dividend was not paid.

Participating and Non-participating shares: The holders ofparticipating preference shares get a share in the profits of the companyafter a certain date of dividends is paid to the equity shareholders of thecompany.

Redeemable and Non- redeemable Preference shares:Redeemable preference shares are repayable at par or at premium after a

specific period. Non-redeemable preference shares are not repayableexcept when a company goes into liquidation.

Convertible and Non- convertible Preference shares:Convertible preference shares can be converted into equity shares at theoption of the preference shareholders in accordance with the certain

predetermined terms. Non-convertible shares do not carry such an option.


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Advantages:1. There is no legal obligation to pay preference dividend.

2. Preference capital is regarded as part of net worth.

3. Preference shares do not, under normal circumstances, carry

voting rights.

Disadvantages:1. Compared to debt capital, it is more expensive source of

financing.2. Skipping preference dividend can adversely affect the imageof the firm in the capital market.

3. Compared to equity shareholders, preference shareholders

have a prior claim on the assets and earnings of the firm.


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Public offering

Rights issue

Private placement

Methodsof Offering/Raising

Finance


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It involves sale of securities to the membersof the public.

There are three types of public offering asunder:Initial public offering(IPO)Seasoned equity offeringBond offering

Public offering


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It is the first public offering of equity shares ofa company, which is followed by a listing of

its shares on the stock market.The decision to go public is a very important

issue. It is a complex decision so carefullytaken Benefits over Cost.


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The company has a certain track record ofprofitability and a certain minimum net worth.

The securities are compulsorily listed on a

recognized stock exchange, which means that acertain minimum percent of each class ofsecurities is offered to the public.

The promoter group is required to make acertain minimum contribution to the post issuecapital.

The promoters contribution to the equity issubject to a certain lock-in period.


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Subscription and allotment

Marketing

Due diligence and prospectus preparation

Hiring the merchant bankers


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Also called Secondary offerings.As companies need more finances, they are

likely to make further trips to the capitalmarket with seasoned equity offering.The process of this is easy than that of IPO.


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It is similar to IPO process, though somedifferences are there:

The prospectus for a bond offeringemphasizes a companys stable cash flows,whereas prospectus for an equity offeringcompanys growth.

Book building method is not used. It is necessary for a company to appoint one

or more debenture trustees before adebenture issue.


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A rights issue involves selling securities in theprimary market by issuing rights to the

existing shareholders.When a company issues additional equity

capital, it has to be offered in the firstinstance to the existing shareholders on a prorata basis.


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It consists of four forms , i.e. forms A,B,C and D. Form A is meant for the acceptance of the rights

and application of additional shares. It has also a

column through which a request for additionalshares may be made. Form B is to be used if the shareholder wants to

renounce the rights in favour of someone else. Form C is meant for application by the

renouncee in whose favour the rights have beenrenounced, by the original allottee.

Form D is used to make a request for split forms.


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A private placement is an issue of securities to aselect group of persons not exceeding 49.

Private placement means direct sale of securities

to a small number of investors. These investors are financial institutions , Banks. This method is very popular because it saves

time and cost. Private placement of shares can be of two types: Preferential allotment Qualified institutional placement


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Public issue Right issue Privateplacement

Amount that canbe raised Large Moderate Moderate

Cost of issue High Negligible Negligible

Dilution of control Yes No Yes

Degree of underpricing Large Irrelevant Small

Market perception Negative Neutral Neutral


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Firms obtain long term debt mainly by raisingterm loans or issuing debentures.

Term loans given by financial institutions andbanks have been the primary source of longterm debt for private firms and most publicfirms.


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Currency

Security

Interest paymentand principalrepayment

Restrictivecovenants


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Submission of loan application.

Initial processing of loan application.

Appraisal of the proposed project.

Issue of the letter of sanction.

Acceptance of the terms and conditions by the borrowing unit.

Execution of loan agreement.

Creation of security.

Disbursement of loan.

Monitoring.


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Cash credits/overdrafts. Loans.

Purchase/discount of bills.


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Predetermined limit for borrowing isspecified by bank.

Borrower can draw as often as required within that limit. Borrower enjoy the facility for repaying the

amount , partially or fully and when he desire. Interest is charged only for the running

balance.


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Advances of fixed money to the borrower. Interest charged on the entire loan amount.

Payable either on demand or in periodicinstallments.


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Arrangement whereby a bank help itscustomer to obtain credit from its supplier.

Letter of credit Here bank take responsibility to honour the

obligation of its customer if the customerfailed to do so.


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The information furnished in the applicationcovers the following..

Name and the address of the borrower andhis establishments. Detail of the borrowers business. Nature and amount of security offered. Financial statements and financial projections

of the firm.


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Involve examination of the following factors. Ability, integrity and experience of the borrower

in the particular business.

General prospects of the borrowers business. Purpose of advance. Requirement of the borrower and its

reasonableness. Adequacy of margin. Provision of security. Period of repayment. Repayment capacity.


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The amount of the loan or the maximum limitof the advance.

The nature of the advance. Period for which the advance will be valid.


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Rate of interest applicable to advance. Insurance of the security.

Details of the collateral security. Margin to be maintained. Other Restriction and obligations on the part

of borrower.


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Hypothecation-owner of goods borrowsmoney against the security of movable

property.

Pledge-owner of goods deposits the goodswith the lender as security for borrowing.


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Deferred credit- Under this the supplier gives time to the

buyer to pay for the machinery. But bank guarantee should be furnished by

the buyer.

Lease finance- Contractual agreement whereby the lesser

grants the lessee the right to use an asset inreturn for periodic lease rental payments.


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Intermediate term to long term noncancelable arrangement which vary from

three, five or eight years. The lesser recovers through the lease rentals

and acceptable rate of return. The lessee is responsible for maintenance,

insurance and taxes.


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The lease term is less then the economic lifeof the equipment.

Lessee enjoy the right to terminate the

contract at short notice without any penalty. The lesser provides the know how and the

related services and responsibility of insuring

and maintaining the equipment.


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Most leases are finance leases not operatingleases.

Lease finance is available for identifiable

performing assets. Lease finance is available in small volume. There is great deal of flexibility in structuring

lease finance. Lease of immovable assets is not possible bybanks.

Lease tenors up to eight years is available.


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The hiree purchases the asset and gives it onhire to the hirer.

Hirer pays regular installments over specified

period of time. With the payment of last installment the

asset is transferred from hiree to the hirer.

Hiree charges interest on flat basis not ondiminishing rate.


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Similar to the hire purchase but here the titleof the assets is transferred from hiree to thehirer when he pays his first installment.

In case of default the hiree can force thebuyer to sell the asset and recover hisremaining amount.


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Provided by the promoters to fill the gapbetween the promoters contribution

required by the financial institution and theequity capital subscribed to by the promoter. These are the deposits from the public with

tenor one to three years


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Bill rediscounting scheme- Operated by the IDBI. Meant to promote the sale of indigenous

machinery on deferred payment basis.Suppliers line of credit- Administered by ICICI. Under this scheme the bank directly pays to the

machinery manufacturer against usance billsduly accepted or guaranteed by the bank of thepurchaser.


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Subsidies and sales tax deferments andexemptions-

Provide subsidies to industrial units located inbackward areas.

Under sales tax deferment scheme the paymentof sales tax on the sales of finished goods maybe deferred for a period.

Commercial paper- Issued by firms which enjoys a high credit rating. Maturity period ranges from 90 to 180 days. Sold at discount and redeemed at par.


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Factoring- A factor is a financial institution work as a

mediator between the creditor and thedebtor.

Factoring may be recourse basis or non-recourse basis.

Factor charges a commission which may be 1to 2 percent of the face value of the debtsfactored.


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Euromarkets ForeignDomesticMarkets

ExportCreditScheme


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1. Composed of Eurobanks who accept ormaintain deposits of foreign currency

2. Dominant currency: US$


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caused by restrictive US government policies,especially

1. Reserve requirements on deposits2. Special charges and taxes3. Required concessionary loan rates4. Interest rate ceilings

5. Rules which restrict bankcompetition.


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1. A chain of deposits

2. Changing control/usage of deposit


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3. Eurocurrency loans

a. Use London Interbank Offer Rate: LIBOR as

basic rate

b. Six month rollovers

c. Risk indicator: size of margin between costand rate charged.


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4. Multicurrency Clauses

a. Clause gives borrower option to switch

currency of loan at rollover.

b. Reduces exchange rate risk


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5. Domestic vs. Eurocurrency Markets

a. Closely linked rates by arbitrage

b. Euro rates: tend to lower lending, higherdeposit


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1. Recent Substantial Market Growth-due touse of swaps.

Financial instrument which gives 2 parties theright to exchange streams of income overtime.


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2. Links to Domestic Bond Market arbitragehas eliminated interest rate differential.

3. Placement underwritten by syndicates ofbanks


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4. Currency Denominationa. Most often US$b. Cocktails allow a basket of currencies

5. Eurobond Secondary Market result of risinginvestor demand

6. Retirementa. sinking fund usuallyb. some carry call provisions.


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7. Ratingsa. According to relative riskb. Rating AgenciesMoodys, Standard & Poor

8. Rationale For Market Existencea. Eurobonds avoid government

regulationb. May fade as market deregulate


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E. Eurobond vs. Eurocurrency Loans International bond denominated in a currency not native to the country

where it is issued. Also called external bond.

A Eurodollar bond that is denominated in U.S. dollars and issued inJapan by an Australian company would be an example of a Eurobond.

1. Five Differencesa. Eurocurrency loans use variable rates

b. Loans have shorter maturitiesc. Bonds have greater volumed. Loans have greater flexibilitye. Loans obtained faster


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F. Note Issuance Facility (NIF)A syndicate of commercial banks that have agreed topurchase any short to medium-term notes that a borrower

is unable to sell in the Eurocurrency market.

1. Low-cost substitute for loan2. Allows borrowers to issue own notes

3. Placed/distributed by banks


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G. NIFs vs. Eurobonds

1. Differences:

a. Notes draw down credit as neededb. Notes let owners determine timing

c. Notes must be held to maturity


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Foreign Domestic Markets


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Most firms raise their initial capital in theirown domestic market

While many can be tempted to skip the

intermediate steps to complete anEuroequity issue in global markets, goodfinancial advisors will offer a reality check onthis strategy

Most firms that have only raised capital intheir domestic market are not well enoughknown to attract foreign investors


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Depositary Receipts Depositary receipts are negotiable certificates issued by a

bank to represent the underlying shares of stock, whichare held in trust at a foreign custodian bank Global Depositary Receipts (GDRs) refers to certificates traded

outside the US

American Depositary Receipts (ADRs) are certificates traded inthe US and denominated in US dollars

ADRs are sold, registered, and transferred in the US in the same

manner as any share of stock with each ADR representing somemultiple of the underlying foreign share


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Depositary Receipts

This multiple allows the ADRs to possess a priceper share conventional for the US market

ADRs are either sponsoredor unsponsored

SponsoredADRs are created at the request of aforeign firm wanting its shares traded in the US;

the firm applies to the SEC and a US bank forregistration and issuance


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Export Credit Schemes


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Prominent Export Agencies US EXIM,JEXIM, HERMES, and COFACE

Follow certain consensus guidelines forsupporting exports under Berne Union

Interest Rate is regulated Two Kinds of Export Credit

Buyers Credit

Suppliers Credit


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The overseas exporter and the Indian Buyernegotiate a contract

An application for the buyers credit facility ismade to the export agency of the exporterscountry along with relevant details

The buyers credit facility is approved by the

export credit agency f the exporters country A negotiated loan agreement delineating the

terms and conditions


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The overseas exporter notifies his bank andthe export credit agency of a potential exportorder of an Indian buyer who requiresmedium term finance

The export credit agency communicates tothe bank its willingness to provide the facility

The terms of the facility are incorporated inthe contract between the overseas exporterand the Indian Buyer.


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Documents

Financing of Projects